Social Currency

“The bomb buried in Obamacare explodes today,” Rick Ungar declares in a December 2^nd Forbes blog post describing a regulatory provision in the Affordable Care Act:

"[T]he medical loss ratio...requires health insurance companies to spend 80% of the consumers’ premium dollars they collect—85% for large group insurers—on actual medical care rather than overhead, marketing expenses and profit. Failure on the part of insurers to meet this requirement will result in the insurers having to send their customers a rebate check representing the amount in which they underspend on actual medical care."

If this regulation is indeed a bomb, then nonprofit administrators must now be totally shell-shocked from navigating the demands of donors, institutional funders, government agencies charity rating agencies, consultants and even board members who want similar oversight of the ratio between program and administrative or fundraising expenditures and then use that data to make claims about operational efficiency. 

The fact that this kind of ratio system is now being applied prominently to a for-profit industry gives us an opportunity to highlight the way similar measures have served as a minefield in the nonprofit sector for years.

The differences between nonprofits and insurance giants are more striking than the similarities. As for-profit entities, insurance companies’ customers are expected to pay a market rate for their services, these funds are always unrestricted, annual surpluses are encouraged rather than stigmatized, and financial gain is the primary motivator.  None of these apply broadly to nonprofits.

Presumably as a matter of public policy, the medical loss ratio is being applied to insurance companies because those companies might otherwise spend even more on lavish executive salaries, luxurious offices, and so on.  But, in an environment where nonprofits face restricted grants and overall scarcity of funds, not to mention baseline commitment to mission, what would be the equivalent goal for imposing such ratios on the nonprofit sector?  Are such measures likely to be successful in inducing “operational efficiency?” 

In posts following up on Ungar’s initial article, Sarah Kliff (on the Washingon Post’s site) and Ungar raise the issue of how the government will define which expenses qualify as direct medical care, which will be administrative expenses, and which expenses could be left out of the equation altogether.  Many of these particulars seem to be addressed up front in the legislation, though one assumes that the financial staff of insurance companies will ultimately find room for interpretation. 

For the nonprofit sector, too, that room for interpretation is significant. An information sheet created by the Nonprofit Assistance Fund lists the two sets of administrative and fundraising expense definitions provided by the IRS and FASB, respectively.  Neither set of definitions is terribly detailed.  Moreover, as NAF notes, they are not consistent with one another.  Each nonprofit is left to slice and dice the significant grey area between program and administrative expense with a variety of allocation methodologies, trying to maximize the program side of the ratio.  As a result, the data are virtually useless to donors in evaluating any individual organization, much less comparing its performance to another. 

More importantly, for nonprofits, the drive to maximize direct programmatic expenditures as a percentage of the total budget often leads to inadequate investment in administrative infrastructure. As a result, nonprofits end up relying on sweat equity to generate programmatic results with, well, explosive results for organizational sustainability. 

So, the Procrustean bed of the fixed ratio fails in two dimensions: (1) It is too blunt an instrument and too susceptible to manipulation to tell us anything of value in most cases, and, for nonprofits in particular, (2) the fixation on adherence to the ratio can undermine just what it seeks to reinforce—the efficient, reliable provision of services over the long term. One might be given to wonder, as Ungar does, whether that isn’t precisely what it is designed to do! 

I don’t want to argue against regulation for the insurance industry.  Nor do I think the nonprofit sector should be free from oversight.  However, it does seem reasonable to expect that methods of regulation, oversight and evaluation be tailored to fit the industries they address.  Expenditure ratios may or may not be effective in regulating the insurance industry, but for nonprofits it’s high time to move onto other measures.